Why investors should stay the course, but adjust their sails

While investors should still maintain a disciplined approach within their core portfolios, the current uncertainty in the markets also calls for a tactical allocation to quality and inflation protection, according to one ETF expert.

“First off, stay the course with core,” says Prerna Mathews, Mackenzie Investments’ vice president for ETF Product & Strategy. “What’s important for investors is to have a core portfolio constructed, that still continues to align to their risk tolerance as well as their investment time horizon.”

With respect to satellite allocations, Mathews suggests quality should be the focus generally across asset classes. In the realm of fixed income, that means looking at increased allocations to quality investment-grade bonds, or revisiting them in cases where investors or advisors removed their exposure to them.

“Whether we're talking about Canadian aggregate bonds or maybe US investment-grade bonds, it could help them be better prepared for the rally that could follow as we come out of this recession-like environment,” Mathews says. “Quality is going to matter moving forward in the near to mid-term, more than it has for quite some time.”

Dividend-paying companies are increasingly in vogue as a haven for many Canadians, particularly as inflation puts the need for income in focus. Mathews says quality should be the watchword in that space as well, given the continued near-term volatility and potential economic slowdown coupled with pressure on corporate earnings.

“We're seeing this already in many sectors. High-yielding companies without strong financial strength and discipline may not be able to sustain future payouts,” she says. “High-quality companies with a history of dividend growth, which are in a good financial position in terms of earnings and earnings quality and leverage, can help offset the risks of a sudden drop in that portion of the portfolio that some investors rely on for income.”

While the consumer price index has started to pull lower, Mathews notes that it’s still high compared to recent history. For investors in the U.S. fixed-income space, Treasury Inflation Protected Securities (TIPS) are another sound option for satellite portfolio diversification in the short to medium term.

Looking at alternative asset classes, infrastructure is also coming up as a post-pandemic portfolio opportunity. Aside from delivering consistent returns, many infrastructure companies benefit from the ability to protect their revenues through market cycles, either through long-term contracts shielded with CPI reference pricing or the ability to set prices as they operate in a monopolistic market.

“I think infrastructure, along with utilities and some other defensive categories, hasn't been in the spotlight for quite some time. Prior to the pandemic, public infrastructure wasn't really top of mind among advisors and investors because they had other spaces to invest in with higher returns,” Mathews says. “Now we’re also seeing more private infrastructure solutions that offer the potential for significantly higher returns than publicly listed options.”

The umbrella of infrastructure is expanding significantly: beyond traditional categories such as roads, waterworks, and energy, communication towers and data centres are emerging as projects that are essential to secure countries’ long-term growth and development. Contracts for infrastructure builds also often stipulate penalties for cancellations, giving governments who enter into them an additional incentive to push through even in the face of recession.

“In this kind of environment, investors can really benefit from being in a sector where you've got some consistency in return and in yield. So it’s more attractive today than many other portions of the equity market,” Mathews says. “It’s a great way to build in some protection, ultimately into the portfolio from an allocation standpoint.”